How do my investments get taxed?

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Where money goes, taxes follow

Do you ever dream of living in a time without taxes? Well, you’d have to travel back to the early 1700s to make it happen, because taxes have been a part of American life since the first estate tax around 1797. And the federal income tax was enacted in 1913. The bright side of taxation? Taxes helps keep America’s roads and bridges safe, fund public schools, and pay for our amazing firefighters and police officers. We’re all in this together!

Consider the tax impact of investing

As we’ve covered in Lionomics before, taxes are an important factor for investors. You need to consider the tax status of your investments, whether they are subject to capital gains or ordinary income, and how long you’ve held them in your portfolio. Because this can have an impact on your portfolio returns, it’s helpful to seek professional advice to understand all of the tax implications. Although we’re not tax experts, we’ll explain these three broad areas briefly.

Taxable vs. tax-exempt investments

First, some investments are taxable, while others may be tax-exempt. Most typical stocks and bonds held in standard brokerage and non-retirement accounts are subject to taxes. However, the interest paid by many municipal bonds is free from federal taxes and may have local tax benefits as well.

Investments in Roth IRA accounts are also free from taxes when you sell at a later date, though you’re taxed on the funds before you contribute them (remember, in a traditional IRA, you’re not taxed upon contribution, but you’re taxed upon sale). Thus, it’s important to understand what you hold and in which accounts you hold it. And, of course, there are important investment strategies to consider based on the types of tax treatment to which different investments are subject.

Taxes come into play when you sell

Second, taxes may be owed if you sell your investments for a gain (i.e., generate capital gains) or if you receive income from investments like bonds in taxable accounts.

It’s also important to note that only net gains are taxable. For instance, if an investor has a long-term gain of $500 on one asset and a long-term loss of $250 on another asset, the taxable amount is the net $250 gain in that particular year. One way some investors take advantage of this is through “tax loss harvesting” – the selling of a security with a loss in order to offset a gain elsewhere. There are specific rules on how these gains can be offset, so again it’s important to seek professional advice.

Know when to hold ‘em (away from taxes)

Third, how long you’ve held your investment can determine how you’re taxed. Specifically, investors need to be aware of whether they will generate short-term or long-term gains when selling assets, because the nature of the gains impacts how they are taxed.

Short-term gains (investments held for less than a year) are taxed as ordinary income and subject to your current income tax rate, which can be as low as 10% or high as 37% for the highest earners. The tax rates on long-term capital gains are significantly reduced based on your income bracket, at 0%, 15%, or 20% for 2018. You should consult a tax or investment professional if you have further questions about this.

Savvy investors can minimize tax losses

Taxes are an important consideration when making investment decisions – they shouldn’t just be an afterthought. Taking advantage of tax-advantaged accounts and being savvy about what constitutes a taxable event can help to maximize the value of your portfolio.

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